A few years ago, I read a thought-provoking essay. The
author argued that the financial services industry was vastly overrated, and
overvalued from the capital markets point of view. I was reading the article
with only a mild interest until he presented the clincher argument. He
estimated the salaries we pay to financial services professionals and the profits
generated by the industry were excessive relative to the value they provide to
mankind. His rationale was that they don’t really produce anything physical. He
presented some crude estimates of the salaries of the financiers relative to,
say, teachers, soldiers and engineers. I
believe the writer was Eric Sprott, but don’t quote me.
Several years later, while financial services is still a
large industry, it is considerably less than what it was years ago. Several big
players (AIG, Bear Stearns and Lehman) have disappeared altogether. Citi is a
shadow of what it used to be. College kids don't plan on taking a 6 months course on securities and becoming a financial advisor. The anomaly that the article spotted has been
dealt with by the market forces. Some say the financial services bubble is
still bursting.
What does all this have to do with Apple? Think about this –
a company that produces neat devices, largely for entertainment (well-designed,
clever, creative, I grant you all that) is now the most valuable company on
the planet. Some of its output is used for producing value and wealth, but a
large part of what it makes has no more than recreation and entertainment
value. You may argue that Apple’s products get used for communication and
business as well, but that’s a stretch. Apple’s products have very close
substitutes in those areas. It’s the design novelty and cultish following that
encourage people to pay a premium for Apple’s products.
What does this tell us? Does it mean profitability or
expected profitability of business has nothing to do with the value a business
holds for our living? Have we just temporarily lost sight of what’s important
for the world economic activity, lifestyle and the like? Or are we awarding
Apple this kind of importance because it provides us the escapism we need from
the stressful economic realities of these days?
Is the importance we assign to entertainment and
communication device maker, and the market cap that we’ve awarded to company as
a result rational? Or is this just a mistake, a fleeting aberration? Are we
going to see the light in a year or two? Are we going to be asking “what the
hell where we thinking?” 5 years from now? You know, like we did after the
dot-com days?
To put some real numbers behind this argument, I’ve drawn a
chart based on the market capitalization of market leaders in various
industries – Apple, Microsoft, Walmart, Shell, Johnson and Johnson, Pfizer,
Coke, HSBC, Toyota and Disney.
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| Companies and Market cap - as of 14th September, 2012 |
I know financial markets work on profits and expected
returns, so the difference in market cap can be simply explained away with
growth rate and profit margins. Apple is certainly doing well in those respects,
perhaps substantially better than the other leaders in the list. However given
the importance of its products in the scheme of things, are the profits high
simply because of a fleeting delusional behavior on our part? Do we really expect
the profitability and growth rates to be sustainable?
Radical innovation is easier when you are defining a market,
as opposed to defending one. All companies get to a stage where they get too
big to be innovative. Given that it’s already the biggest company on the
planet, is Apple already there?
